I liked Noah Smith’s piece and I don’t mean to pick on him, but…

by on January 16, 2015 at 1:53 am in Economics | Permalink

His recent coverage offered a simple means of testing my earlier claim that not one in fifty economists understands the Heckscher-Ohlin theorem (HOT).  Noah wrote:

No. 9. The Hecksher-Ohlin theorem

This is a theory about trade. It says that countries with more capital — industrialized countries such as the U.S. or Japan — will tend to make things that are more capital-intensive. And countries with more labor — such as India — will tend to make things that are more labor-intensive. That’s why the U.S. makes a lot of semiconductors (which require huge fabrication plants), and India makes a lot of clothes.

Admittedly, some of the problems in this may stem from the reality that Noah is writing for a largely non-academic audience.  Nonetheless here are a few points:

1. The HOT proposition is about exports being relatively capital- or labor-intensive, not about production per se.  Even for a popular audience, I think that substitution should have been easy enough.

2. In the HOT literature there is a tension between quantity of labor and quality of labor, or human capital.  Some researchers wish to consider the United States as a labor-intensive country for this reason, because in value terms, rather than “counting bodies” terms, we have a lot of talent.  That also might help explain Silicon Valley exports and also entertainment exports.  Indeed it has been known since Leontief that U.S. exports are relatively labor-intensive, not capital-intensive.

3. The HOT claim is about a country’s capital to labor ratio, so that India has “more labor” is not exactly right, rather India has a lot of labor relative to its supply of capital.  Again, this simplification may have been imposed on Noah by the medium, but I am not convinced that the notion of a ratio here is beyond those who read economics on Bloomberg.

4.  Here is a recent headline: “China just surpassed the U.S. in semiconductor manufacturing, and the trend is likely to continue.”  I say China and the U.S. don’t have the same strengths when it comes to factor endowments, yet they are both producing lots of semiconductors (NB: I don’t have data handy on Chinese semiconductor exports).   Probably semiconductors are a classic example of economies of scale, knowledge economies, and specialization.  In that case the Heckscher-Ohlin theorem ought not to apply and we move closer to the trade work of Paul Krugman and others.  HOT also assumes that all countries enjoy the same state of technical knowledge, which seems doubtful when it comes to semiconductors, and thus maybe relative factor endowments are not doing the work in this case.  It seems like semiconductors are an example deliberately chosen to stand as far apart from the Heckscher-Ohlin assumptions as possible.

Now Noah knows way more economics than most economists, and thus I continue to believe most economists don’t have such a clear sense of the Hechscker-Ohlin theorem.  There are so many tricks to HOT I wouldn’t be surprised if I slipped up somewhere myself in this post.

1 Pseudonymous January 16, 2015 at 2:00 am

>Now Noah knows way more economics than most economists

If your definition of “most economists” is “most economics professors working or educated at GMU,” then perhaps. Noah doesn’t know about much other than the ‘macro wars.’ Take his recent embarrassing comments on Frank X. Diebold’s latest blog post, for instance.

2 Art Vandalay January 16, 2015 at 9:37 am

You could also include “economists” who don’t have PhDs and spend their time doing transfer pricing. In any case, Noah doesn’t have a clue about economics — the proof is in his staggering number of publications.

3 Noah Smith January 16, 2015 at 2:12 am

Tyler:

Haha, good points all. And thanks for the kind words. And also for not pointing out that my “explanation” of Mike Woodford’s book didn’t actually include an explanation! 😉

I hoped that laypeople would interpret “make” as “export”, since that’s how they seem to use the term when they say we “don’t make things in America anymore”, etc. I also hoped that they would interpret to mean “countries that have more capital” to mean “countries that have a higher capital-to-labor ratio than other countries”.

But, they probably won’t. Oh well.

4 Michael G Heller January 16, 2015 at 3:31 am

Haha? That about sums it up.

5 Michael January 16, 2015 at 8:06 am

Embarrassed laughter from an embarrassed man.

6 Tom January 16, 2015 at 3:48 pm

I thought Tyler was joking when he said only one in 50 economists understand the HOT theorem. It is after all as simple as Noah says. But no, Tyler apparently thinks he is one of the rare enlightened few who can almost grasp these deeply complicated topic, and even he has trouble. Sometimes Tyler is a total kook.

7 Jonathan January 18, 2015 at 3:29 pm

Noah — You conceded #1 too quickly. The Heckscher-Ohlin IS about production per se. http://tradediversion.net/2015/01/18/what-the-heckscher-ohlin-theorem-is-and-is-not-about/

8 JC January 16, 2015 at 2:32 am

I’m feeling dumb because I’m confused 🙂

9 Ray Lopez January 16, 2015 at 4:37 am

re HOT, in #4, TC seems to make (but with a caveat “N.B.”) the same mistake he chides Noah Smith on: China’s making of ICs is *not* for export but as the linked article says: “Consumption of microchips in China is exploding—and more and more of them are being sourced locally.” and keep in mind (not mentioned in the article) China’s semi fabs are for producing ‘dumb’ ICs like used in smart phones (sic), not high-tech ICs used in PCs, like Intel makes in more high-tech plants outside of China. And, as the article says, Taiwan is still the leader of high-tech ICs with TSMC. BTW, the way semi fabs are automated these days, you don’t really need ‘factor endowments’ or some such, just a good place with clean water and warm bodies to build a semi fab plant. Intel has high-tech PC chip plants in Costa Rica as well as Arizona, USA, two highly different places, and I bet the HOT theory has very little to say about such historical accidents.

10 Viking January 16, 2015 at 11:34 am

To elaborate on Sr. Lopez, in terms of total semiconductor revenue, China is only a tiny blip, in 2013, SMIC had $2Billion in revenue, less than one thirteenth that of Intel.

https://en.wikipedia.org/wiki/Semiconductor_sales_leaders_by_year#Ranking_for_year_2013

Saying China has surpassed USA in semiconductors is nearly analogous to saying the the US are leaders in passenger rail construction. USA easily spends way more than even wealthy European countries (at least on a per mile basis):

http://secondavenuesagas.com/2010/01/14/the-costs-of-second-ave-construction/

And China only leads in semiconductor inputs, not outputs. Thus China spends the most silicon per unit revenue.

11 chuck martel January 16, 2015 at 6:17 am

“Admittedly, some of the problems in this may stem from the reality that Noah is writing for a largely non-academic audience.”

Trying to reach the unwashed masses isn’t easy for academics delivering complex ideas in a different dialect.

12 prior_approval January 16, 2015 at 8:05 am

But it is really easy for people like the chairman and the general director of the Mercatus Center – after all, in that persona, they are in no way, shape or form part of academia. Regardless of the fond fantasies motivating at least some donor checks, and whatever other positions or titles (such as being a person with life long tenure at an academic instutition funded by the taxpayers of the Commonwealth of Virginia) they may hold.

13 rayward January 16, 2015 at 7:05 am

“You’re missing the overall.” That’s Deep Throat wisdom. Something economists should keep in mind. Economics was simpler 45 years ago when I studied it as an undergraduate (it was my major). In particular, comparative advantage was something most everyone could agree on, left, right, and middle. There were developed countries and there were less developed countries (LDCs as they were called so as not to offend them with the term undeveloped and to acknowledge that it’s all relative anyway), and they cooperated (relatively speaking) in confirming classical trade theory (HOT). Today, not so much. So we have the New Trade Theory and the New New Trade Theory. And soon enough the New New New Trade Theory. I say remember Deep Throat.

14 Toby January 16, 2015 at 7:11 am

Tyler, would it be correct to rephrase that your claim is about that most economists wouldn’t know how to bring the theorem to the data? That is how to apply it?

I don’t know if the earlier claim was meant to be shocking, but is it really that much of a surprise? If some knowledge is not used for a considerable period of time it tends to atrophy. Most economists probably don’t use all their knowledge all the time, so they’ll probably have to give how to apply the HOT some thought when using it again.

Which brings me to another question. Do you mean that they’re incapable of applying it when you wake them up at 2 am at night, or do you mean that they’re incapable of applying correctly it in published (academic) work? I’d say that incentives might matter here. What is the incentive to give it some thought if it has few if any consequences? Wouldn’t you rather save the energy for something else?

15 rayward January 16, 2015 at 7:29 am

For those unconvinced by the wisdom of Deep Throat, consider Peter Thiel, who said: “We live in a financial and capitalist age, not a scientific or technological age. . . . with innovation in the world of bits, but not in the world of atoms”. Classical trade theory doesn’t work so well in the world of bits.

16 Rich Berger January 16, 2015 at 8:21 am

I enjoyed this from NS article:

So far, DSGE models haven’t found much use outside academia, though they have won a couple of Nobel prizes.

Like video games for the uber nerds.

17 In the sky January 16, 2015 at 8:40 am

“So far, DSGE models haven’t found much use outside academia, though they have won a couple of Nobel prizes. – See more at: http://marginalrevolution.com/marginalrevolution/2015/01/i-liked-noah-smiths-piece-and-i-really-dont-mean-to-pick-on-him-but.html#comments

This is a ridiculous comment by Noah. DSGEs are used to help set monetary policy by every central bank in the world.

18 Noah Smith January 16, 2015 at 11:11 am

Actually, I’ve talked to lots of central bankers, and I don’t think DSGEs are used much to guide policy (except maybe in Scandinavia!). Certainly not very much in the U.S. or Japan or the UK. They are used, mainly as a sanity check on discretion and on reduced-form models. So as a class they haven’t found *zero* use.

And the vast, vast majority of DSGE models have found exactly zero use outside academia. I’ve only ever heard of one single DSGE model being used by central bankers – the Smets-Wouters model, or a close variant.

19 In the sky January 16, 2015 at 11:38 am

DSGEs are used by central banks the world over. We can quibble about whether their use as “a sanity check” amounts to “helping to set monetary policy”, but you have just admitted they are used throughout the world. Indeed, in terms of day-to-day use in policy circles, few things from economics used more frequently.

I agree that much of the DSGE paradigm has been flawed, Noah. That doesn’t warrant your misleading jibe.

20 Rich Berger January 16, 2015 at 11:31 am

That’s a relief. Somebody better tell Scott Sumner that he can forget NGDP targeting.

21 FC January 16, 2015 at 8:52 am

Any prediction markets taking bets on whether Smith will get tenure?

22 Art Vandalay January 16, 2015 at 9:36 am

When the probability is zero and everyone knows it, insurance markets tend to shut down.

23 Bob Flood January 16, 2015 at 9:49 am

For very small countries, e.g., people, where trade is most important , the HO and Ricardian models become indistinguishable. It’s only when trade becomes less important that HO factor proportions set in. I kind of like to interpret the world with fixed factor models and some increasing returns.

24 Nathan W January 16, 2015 at 10:27 am

The Stolper Samuelson theorem is broadly similar, but their developments of it (and contemporary critiques thereof, if my memory serves me right) are more allowing for factors which explain high trade between countries which have similar economic structure, for example between Europe and USA which both have very high capital. This contradicts H-O, but when considering that advanced production systems are more likely to have complementarities, and also similarities between tastes and depth of purse of consumers, it is easy to understand.

I think both perspectives are very useful in understanding dynamics of global trade and factors which offer prospects for economic development in rich and poor countries alike. But neither constitutes a unified theory or any such thing. They are simplistic tools which are easily taught and offer great bang for your buck in the understanding they may procure for students.

25 Nathan W January 16, 2015 at 10:33 am

One of the greatest misapplications of H-O is in advice given to developing countries in earlier decades. It was the conventional wisdom that in order to get rich, they must develop modern agriculture.

While an agricultural surplus, or a larger one, surely could not hurt development prospects, it is high value added areas of production, with greater oportunities for economies of scale and learning by doing, which leads to higher productivity, higher wages, and which THEN lead to agricultural modernization BECAUSE it is too expensive to hire labour for the farms.

Certainly there are many opportunities for gains in improved agricultural productivity. But since when did anyone get rich making things that anyone could make, and have been making for 10,000 years?

Presumably many of these advice givers were hopeful that it was decent advice, but it would be naive to think that many were also aware that this amounted to a development strategy which would reduce the level/extent of competition in areas that industrialized countries were active in.

It is a useful analytical tool, but even just 10 years ago, was still regularly used to motivate development theories which essentially consigned Africa and Asian farmers to competing with the heavily subsidized Western agricultural production and de-motivated them from industrialization strategies.

26 Clover January 16, 2015 at 5:01 pm

Implicit in a lot of neoliberal theory is the notion that the value of an industry to a nation is the same thing as the value of that industry to a capitalist.(It’s not hard to see why capitalists tend to like this system) But in reality industries have benefits to society other than the return they give to their investors. Advanced manufacturing stimulates education among the workers, who it pays higher wages than a cloth factory. Many companies have been started by people who gained education or experience in other companies, or who pursued higher education in order to work in these companies. These benefits are not accounted by “the free market” which just measures the amount of value payed to investors. The free market undervalues advanced manufacturing industries, and this is why in Japan the heavily regulated banks provide artificially cheap capital to the industries, providing a huge advantage in capital intensive advanced manufacturing industries, while the Japanese government provides them with tax breaks.

Thus, I would advise the Bengali government to specifically “subsidize”(for lack of a better word) advanced manufacturing industries in the way that Japan does, instead of resigning itself to it’s fate as the world’s sweatshop, as neoliberals would advise.

27 whatsthat January 16, 2015 at 10:36 am

wots a demand curve

no really

28 Toby January 16, 2015 at 11:45 am

A relationship that exists between quantity demanded of a good and the price of a good.

29 whatsthat January 16, 2015 at 1:20 pm

wots a price

30 paul January 16, 2015 at 12:23 pm

Semiconductor guy here.

The US does *not* make a lot of semiconductors, and neither does China. The big semiconductor manufacturers are in Taiwan (especially TSMC) and Korea (Samsung, SK Hynix). So China passing the US wouldn’t be surprising. But it isn’t even true.

Someone above said China is making “dumb” chips for smartphones. Actually the chips that go in smartphones (such as Apples Ax series or Qualcomm’s Snapdragon) are the most complex and highest volumes SoCs out there, they drive the entire industry to subsequent process nodes (outside of Intel which is a special case being the only integrated device manufacturer these days and even they use TSMC for production of some chips such as their cellular modem).

The actual numbers (based on where chips are manufactured not on where the headquarters is):
US 15%
Europe 2%
Japan 17%
Korea 28%
Taiwan 22%
China 7%
ROW 8%

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